Paper 2021/1605

Inflation-Tracking Proof-of-Work Crypto-Currencies

Abstract

We show that Bitcoin and other existing egalitarian crypto-currencies are unstable as store-of-value as they fail to track inflation of local currencies closely, and the price dynamic is purely driven by speculation. In the case of Bitcoin, we show that instead of price being based on cost of mining Bitcoin, it is the cost of mining that rapidly converges to the current price of Bitcoin. Based on rational expectations equilibrium, we argue that if the coins awarded during mining are increased in proportion to increase in difficulty of the underlying cryptographic puzzle, then the price of the coin is likely to track inflation of local currencies closely over medium to long term. However, since Moore's law as well as targeted hardware design can lead to computational cost deflation, we suggest a hyper-geometric tapering, instead of a geometric tapering, of the mining award over time. This also handles bootstrapping interest in the crypto-currency.

Note: Gave a clear explanation of how Moore's law dictated the design of Bitcoin. This however introduces a circularity in pricing model. Instead of the price of Bitcoin being dependent on the cost of mining Bitcoin, it is the case that the cost of mining Bitcoin converges to current speculative price of Bitcoin.